2. 1
In this chapter, look for the answers to
these questions:
Why do monopolies arise?
Why is MR < P for a monopolist?
How do monopolies choose their P and Q?
How do monopolies affect society’s well-being?
What can the government do about monopolies?
What is price discrimination?
3. 2
Introduction
A monopoly is a firm that is the sole seller of a
product without close substitutes.
A monopoly firm has market power, the ability
to influence the market price of the product it
sells. A competitive firm has no market power.
4. 3
Why Monopolies Arise
The main cause of monopolies is barriers
to entry – other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The govt gives a single firm the exclusive right
to produce the good.
E.g., patents, copyright laws
5. 4
Why Monopolies Arise
3. Natural monopoly: a single firm can produce
the entire market Q at lower ATC than could
several firms.
Q
Cost
ATC
1000
$50
Example: 1000 homes
need electricity. Electricity
Economies of
scale due to
huge FC
ATC is lower if
one firm services
all 1000 homes
than if two firms
each service
500 homes. 500
$80
6. 5
Monopoly vs. Competition: Demand Curves
In a competitive market,
the market demand curve
slopes downward.
but the demand curve
for any individual firm’s
product is horizontal
at the market price.
The firm can increase Q
without lowering P,
so MR = P for the
competitive firm.
D
P
Q
A competitive firm’s
demand curve
7. 6
Monopoly vs. Competition: Demand Curves
A monopolist is the only
seller, so it faces the
market demand curve.
To sell a larger Q,
the firm must reduce P.
Thus, MR ≠ P.
D
P
Q
A monopolist’s
demand curve
8. 7
Understanding the Monopolist’s MR
Increasing Q has two effects on revenue:
• The output effect:
More output is sold, which raises revenue
• The price effect:
The price falls, which lowers revenue
To sell a larger Q, the monopolist must reduce the
price on all the units it sells.
Hence, MR < P
MR could even be negative if the price effect
exceeds the output effect
9. 8
Profit-Maximization
Like a competitive firm, a monopolist maximizes
profit by producing the quantity where MR = MC.
Once the monopolist identifies this quantity,
it sets the highest price consumers are willing to
pay for that quantity.
It finds this price from the D curve.
11. 10
The Monopolist’s Profit
As with a
competitive firm,
the monopolist’s
profit equals
(P – ATC) x Q
Quantity
Costs and
Revenue
ATC
D
MR
MC
Q
P
ATC
12. 11
A Monopoly Does Not Have an S Curve
A competitive firm
takes P as given
has a supply curve that shows how its Q depends
on P
A monopoly firm
is a “price-maker,” not a “price-taker”
Q does not depend on P;
rather, Q and P are jointly determined by
MC, MR, and the demand curve.
So there is no supply curve for monopoly.
13. 12
Case Study: Monopoly vs. Generic Drugs
Patents on new drugs
give a temporary
monopoly to the seller.
When the
patent expires,
the market
becomes competitive,
generics appear.
MC
Quantity
Price
D
MR
PM
QM
PC =
QC
The market for
a typical drug
14. 13
The Welfare Cost of Monopoly
Recall: In a competitive market equilibrium,
P = MC and total surplus is maximized.
In the monopoly eq’m, P > MR = MC
• The value to buyers of an additional unit (P)
exceeds the cost of the resources needed to
produce that unit (MC).
• The monopoly Q is too low –
could increase total surplus with a larger Q.
• Thus, monopoly results in a deadweight loss.
15. 14
Price Discrimination
Discrimination is the practice of treating people
differently based on some characteristic, such as
race or gender.
Price discrimination is the business practice of
selling the same good at different prices to
different buyers.
The characteristic used in price discrimination
is willingness to pay (WTP):
• A firm can increase profit by charging a higher
price to buyers with higher WTP.
16. 15
Consumer
surplus
Deadweight
loss
Monopoly
profit
Perfect Price Discrimination vs.
Single Price Monopoly
Here, the monopolist
charges the same
price (PM) to all
buyers.
A deadweight loss
results(cost to society
created by market
inefficiency,occurs
when supply and
demand are out of
equilibrium)
MC
Quantity
Price
D
MR
PM
QM
17. 16
Price Discrimination in the Real World
In the real world, perfect price discrimination is
not possible:
• no firm knows every buyer’s WTP(willingness to
pay)
• buyers do not announce it to sellers
So, firms divide customers into groups
based on some observable trait
that is likely related to WTP, such as age.
18. 17
Examples of Price Discrimination
Movie tickets
Discounts for seniors, students, and people
who can attend during weekday afternoons.
They are all more likely to have lower WTP
than people who pay full price on Friday night.
Airline prices
Discounts for Saturday-night stayovers help
distinguish business travelers, who usually have
higher WTP, from more price-sensitive leisure
travelers.
19. 18
Examples of Price Discrimination
Discount coupons
People who have time to clip and organize
coupons are more likely to have lower income
and lower WTP than others.
Need-based financial aid
Low income families have lower WTP for
their children’s college education.
Schools price-discriminate by offering
need-based aid to low income families.
20. 19
Examples of Price Discrimination
Quantity discounts
A buyer’s WTP often declines with additional
units, so firms charge less per unit for large
quantities than small ones.
Example: A movie theater charges $4 for
a small popcorn and $5 for a large one that’s
twice as big.
21. 20
CONCLUSION: The Prevalence of Monopoly
In the real world, pure monopoly is rare.
Yet, many firms have market power, due to
• selling a unique variety of a product
• having a large market share and few significant
competitors
In many such cases, most of the results from
this chapter apply, including
• markup of price over marginal cost
• deadweight loss
22. 21
CHAPTER SUMMARY
A monopoly firm is the sole seller in its market.
Monopolies arise due to barriers to entry,
including: government-granted monopolies, the
control of a key resource, or economies of scale
over the entire range of output.
A monopoly firm faces a downward-sloping
demand curve for its product. As a result, it must
reduce price to sell a larger quantity, which causes
marginal revenue to fall below price.
23. 22
CHAPTER SUMMARY
Monopoly firms maximize profits by producing the
quantity where marginal revenue equals marginal
cost. But since marginal revenue is less than
price, the monopoly price will be greater than
marginal cost, leading to a deadweight loss.
Policymakers may respond by regulating
monopolies, using antitrust laws to promote
competition, or by taking over the monopoly and
running it. Due to problems with each of these
options, the best option may be to take no action.
24. 23
CHAPTER SUMMARY
Monopoly firms (and others with market power) try
to raise their profits by charging higher prices to
consumers with higher willingness to pay. This
practice is called price discrimination.
